Mad Adam Carr today takes a tilt at macroprudential:
Five years after the GFC, many nations appear to be lurching head first into yet another housing crisis. In response, increased macroprudential regulation has become the policy du jour, proudly advocated by the International Monetary Fund and widely adopted around the world.
…Suspicion should be raised, however, when what were previously well accepted principles are so easily cast aside.
…Remember that the US housing crisis was not result of insufficient regulation. Instead the crisis was caused by a combination of a housing glut, excessively low interest rates and a generous system of exemptions from existing regulatory oversight…High LVRs themselves did not cause the US housing recession or the global financial crisis. Indeed LVRs overall remained quite constant.
Against that backdrop, moves to re-regulate must be viewed as a draconian intrusion of bureaucrats into the free market…Consequently, the decision simply deprives some citizens, who may have otherwise been able to service their debt happily without incidence, of a home.
…The best way to fix this current dilemma is quite simple. Build more houses and associated infrastructure, enforce existing regulations and keep interest rates appropriately calibrated.
So the US had sufficient regulation that was insufficient? Is Australian housing a free market now? Lol. Are first home buyers priced out now? Yes. Are LVR controls the only option for MP. No.
Yes, Adam, we agree that supply-side reform is needed. Likewise, tax reform would contribute to a solution. But neither is mooted or forthcoming. So, what should monetary authorities do about the clear and present danger of house prices and a high dollar that they face here on the southern continent of planet Earth? There are two options:
- raise interest rates
- install macroprudential
The first is advocated by Paul Bloxham today:
So far, the plan is working. As mining activity slows, other sectors are picking up, albeit modestly, and rising housing prices are part of the story. Australia’s rebalancing act is underway. To drive this, the RBA has held its cash rate at its lowest level in history for almost a year. Rising house prices and low interest rates are driving an upswing in housing construction, which is also part of the plan.
At this stage, the upswing looks like a regular housing price cycle. National housing prices have risen by 16% since their trough two years ago. This followed an 8% decline in the previous two years, so part of the rise is just catch-up. Although housing prices have outpaced income growth in the past two years, they have grown in line with incomes over the past five years. As long as interest rates remain low, we expect the housing boom to continue, with housing price growth of around 10% forecast for 2014 as a whole.
This is where the story gets trickier. Although monetary policy has, so far, done what it is supposed to do, the central bank needs to be wary of creating a build-up of excessive risks along the way. And, while we remain of the view that Australia does not currently have a housing bubble, it seems likely that if the current housing market trends were to persist for too long, there would be a risk of inflating one. Signs of exuberance are most acute in Sydney, where housing prices are already rising at twice the pace of elsewhere and the investor share of market has reached record new highs in recent months. The RBA will need to be wary of not falling into the trap of leaving interest rates ‘too low, for too long’ and driving excessive risk taking in the housing market.
For policy, Australia’s still booming housing market is a key factor that underpins our view that the RBA is unlikely to deliver further cash rate cuts. Indeed, we expect rates will need to rise to rein in the housing market and secure financial stability. We still see rates needing to rise earlier than the market is currently pricing in, with a hike expected as early as H1 2015.
Bloxo sees four rate rises next year. It’s fair to say with a high degree of confidence if the RBA follows his advice then the Australian dollar will head straight back to $1.10 against the greenback. As such, housing will stall, tradables get crushed, nominal growth and the Budget get smashed, the iron ore shakeout turn more violent much earlier and Australia be in recession sooner rather than later. It will certainly prevent further house price gains and perhaps it’s worth the sacrifice.
The second option, macroprudential controls, will stall house price gains and allow further rate cuts to prevent a rout, as well as drop the dollar further, faster, enabling a genuine rebalancing towards greater competitiveness to begin.
That is the nub of the issue. Australia needs to undergo a structural adjustment to rebalance and the RBA has stuffed it badly by unleashing a cyclical bounce via house prices. But that still doesn’t mean that one should now aim to put the cyclical genie back in the bottle using tools that will be make the underlying structural problem worse again.
Macroprudential is not perfect but public policy never is and it’s by far the best option in the circumstances.
